Hong Kong Confidence Builds as Stock Hedges Get Cheaper

By Jonathan Burgos and Kana Nishizawa -
Aug 5, 2014

For Hong Kong options traders, the
stock rally has room to run.

Puts (HSI) with an exercise price 10 percent below the benchmark
Hang Seng Index cost 2.8 points more than calls betting on a 10
percent increase, according to three-month data compiled by
Bloomberg. The price relationship, known as skew, is 15 percent
below the average this year and fell to 0.2 point on July 30,
the lowest since November 2012, the data show. The stock gauge
jumped 6.8 percent in July, the biggest monthly advance since
September 2012 and the most among developed markets.

Investors are betting that low valuations for the city’s
stocks and a government plan to link its bourse with Shanghai
will drive further gains. Policy makers will allow overseas
investors to trade Chinese shares through Hong Kong and wealthy
mainlanders to buy the city’s stocks. A similar 2007 proposal,
later scrapped, helped push the Hang Seng Index to a record.

“There’s more upside for Hong Kong shares as they’re still
trading at a discount to regional markets,” Pauline Dan, who
helps oversee $153 billion as Hong Kong-based head of greater
China equities at Pictet Asset Management Ltd., said by phone on
Aug. 4. “Hong Kong has been a laggard in the global market
rally and it’s starting to see fresh inflows. The proposed
trading link with Shanghai solidifies Hong Kong’s position as
China’s financial center.”

Relative Value

Shares on the Hang Seng Index were valued 11.4 times
estimated earnings yesterday, compared with a multiple of 8.8
times for the Shanghai Composite Index, 13.5 times for the MSCI
Asia Pacific Index and 16.1 for the Standard & Poor’s 500 Index,
according to data compiled by Bloomberg.

The city’s monetary authority bought $8.39 billion in July,
the most since at least October 2012, to defend its currency peg
as share listings, dividends and mergers and acquisitions
spurred demand for Hong Kong dollars.

The July stock rally was tempered on Aug. 1 amid a global
selloff, when the city’s benchmark index fell 0.9 percent, the
most in three weeks. The measure rose 0.2 percent yesterday, the
10th advance in 11 days.

Investors are beginning to appreciate that many Chinese
shares are undervalued, Tim Schroeders, a portfolio manager who
helps oversee $1 billion in equities at Pengana Capital Ltd. in
Melbourne, said by phone on Aug. 1.

China Appreciation

“Growing confidence in the Chinese economy has helped
boost shares in Hong Kong,” Schroeders said. “Hong Kong is
benefiting from increasing demand for Chinese shares. Initially,
there was concern before that Hong Kong will lose its
significance as a financial hub in the region as China opens up
its financial market. Clearly, the move to embrace Hong Kong as
part of that transition is positive for both Hong Kong and
China.”

China’s manufacturing expanded in July at the fastest pace
in more than two years, signaling a pickup in growth amid
government support. Signs that Asia’s biggest economy is
improving pushed the Hang Seng China Enterprises Index of
mainland shares traded in Hong Kong into a bull market last
week, having surged more than 20 percent from an eight-month low
on March 20.

“China just emerged from a downturn and we don’t know if
the improvement is sustainable,” Francis Lun, Hong Kong-based
chief executive officer at Geo Securities Ltd., said by phone on
Aug. 4. “People have enormous optimism on the Hong Kong-Shanghai connect, and that’s already over done.”

Bourse Shares

Hong Kong Exchanges & Clearing Ltd. (388), the world’s largest
bourse operator by market value, has posted the second-biggest
advance among the 50 stocks on the Hang Seng Index this year
through yesterday, with most of the gains coming since Chinese
Premier Li Keqiang on April 10 announced plans for the equity
link.

Calls that profit should the city’s bourse operator advance
10 percent cost 5.8 points more than puts hedging against a 10
percent decline, according to three-month data compiled by
Bloomberg. The price difference climbed to 6 on Aug. 1, the
highest since February 2011. Lorraine Chan, a spokeswoman for
the bourse operator, declined to comment on the options trading.
Hong Kong Exchanges reports quarterly profit figures today.

“The performance of HKEx can be used as a mimic for the
Hang Seng Index,” Castor Pang, head of research at Core
Pacific-Yamaichi in Hong Kong, said by phone on July 31.
“Investors believe that overall market turnover will increase
substantially after the Shanghai link starts in October.”

Most-Owned Options

Four of the five most-owned contracts on the Hang Seng
Index were bullish calls, according to data compiled by
Bloomberg. Investors poured $413.4 million into the iShares MSCI
Hong Kong exchange-traded fund in July, the most since October
2012, after withdrawing funds in the first five months of the
year.

“The rally will continue,” Ben Kwong, a director at KGI
Asia Ltd. in Hong Kong, said by phone on Aug. 4. “There’s still
positive sentiment on the Shanghai-Hong Kong stock connect. That
will boost trading volume and attract more funds flowing in.”